BorgWarner's turbocharged growth leads auto supplier surge

With U.S. auto sales percolating at the best pace since 2007, parts suppliers are riding high, too - and none more so than BorgWarner Inc.

BorgWarner outperformed every auto supplier in North America over the past three years. Shares of the turbocharger maker more than doubled from 2010 through 2012, which means that solid, stolid old BorgWarner, founded in the Roaring '20s, beat some far more stylish companies. From the beginning of 2010, its stock returned four times more than Google Inc.

The question now is whether Auburn Hills-based BorgWarner's hot hand gives new Chief Executive Officer James Verrier a big head start in doing well or an impossibly hard act to follow. The exact split of opinion is telling: Among analysts surveyed by Bloomberg, 12 rate it a buy and 12 a hold. There are no sells.

"He has a significantly tougher job because he's inheriting a business that's operating well and has high expectations," Matt Stover, an analyst with Guggenheim Securities in Boston, said in an interview.

The surge in BorgWarner's market value to $8.75 billion as of Thursday has been part of a rally throughout the U.S. supplier industry. The Bloomberg Industries North American Auto Parts index more than doubled since the start of 2010 to a 52- week closing high of 408.21 yesterday. U.S. employment in the sector, which peaked at 845,900 in June 2000, rebounded to 487,300 in January after bottoming in July 2009 at 386,300, according to the Original Equipment Supplier Association, a trade group.

Company history

BorgWarner was founded in 1928 by a group of entrepreneurs that included the inventor of the first manual transmission, according to the company's website. While it still makes transmission parts, its primary product is turbochargers and it competes in a crowded space that also includes giants Continental AG, Robert Bosch GmbH and Cummins Inc. As recently as April 2010, it was trading at a 64 percent discount to the auto parts index.

That's when the revival of the U.S. car industry began to take hold. Just as important for BorgWarner, governments around the world increasingly began mandating more efficient engines for better gas mileage.

Demand for BorgWarner's turbochargers soared. The company has 29 percent of the U.S. market, ahead of Cummins and Honeywell International Inc., with 27 percent and 23 percent, according to IBISWorld, a Santa Monica, California-based researcher.

Turbochargers compress air to maximize the power an engine produces. Automakers, forced by governments in the U.S., Europe and Asia to improve fuel efficiency and lower emissions, are turning to smaller, lighter engines. They're using turbos to give buyers the power and acceleration they still want.

CAFE rating

"Smaller displacement and forced induction," said Kevin Tynan, auto analyst for Bloomberg Industries in Skillman, New Jersey. "This is the way the industry is going."

The U.S. requires automakers to double their corporate average fuel economy rating, known as CAFE, to 54.5 miles (88 kilometers) per gallon by 2025.

Ford Motor Co. said April 2 that about 40 percent of the F-150 pickups it has sold to individual buyers this year in the U.S. had six-cylinder engines powered by turbos BorgWarner helps supply. As recently as 2010, Ford didn't sell any six-cylinder F-150s.

Light-vehicle makers bought about 25 million turbos globally last year, BorgWarner estimates. By 2017, that number will increase to 41 million, the company projects. Just- Auto.com, a Bromsgrove, England-based market research firm, forecasts as many as 44.9 million by 2017.

Turbocharger stats

Sales of turbochargers for light vehicles alone make up 26 percent of BorgWarner's $7.18 billion in annual revenue. Its customers include Ford, Volkswagen AG, Daimler AG, Hyundai Motor Co. and General Motors Co.

Turbo sales will make up about half of BorgWarner's net new business for 2013 through 2015, according to the company. Of that, 80 percent is outside the U.S., for customers such as Ford, VW, Bayerische Motoren Werke AG and Fiat SpA. China represents about a third of BorgWarner's net new business.

"BorgWarner's portfolio is uniquely situated around fuel efficiency and will play a major role in automakers' ability to meet more stringent requirements," wrote Joseph Spak, an analyst with RBC Capital Markets, who rates BorgWarner the equivalent of a buy, in a research note.

The company's discount to the Auto Parts Index began narrowing after April 2010, according to weekly data compiled by Bloomberg. Investors paid as much as a 55 percent premium for BorgWarner's forecast earnings when compared with the index in July 2012, the data show.

Manganello's record

Tim Manganello

Analysts give credit to Tim Manganello, who was named CEO of BorgWarner on Feb. 5, 2003. He was known for spending to support the business and keeping tight controls on the rest. Visitors to the corporate offices, for example, looked up the CEO's extension from a vinyl binder on a counter next to the phone. No secretary, no comfy waiting area. The nearby research and development center was a bit more plush.

"It's gorgeous," Stover said. "It showed they were putting their money where it mattered. As an investor, you like that."

Manganello, 63, retired at the end of last year. The stock quadrupled under his tenure, while sales more than doubled.

Verrier, 50, then took the helm at BorgWarner. Verrier has been with the company for 24 years. His prior positions have included vice president of BorgWarner's turbo systems and passenger-car products based in Germany. He was named chief operating officer in March 2012.

The CEO declined an interview request, said Erika Nielsen, a company spokeswoman.

Verrier's task

Verrier inherits a company that's not flying as high as it was just recently. The stock has slipped 7.4 percent in the 12 months ended Thursday. BorgWarner this month has traded at a discount to the North American Parts Index for the first time since July 2011, according to weekly data compiled by Bloomberg.

Europe is the culprit. Vehicle sales in the region are headed to the lowest level in 19 years because of the region's sovereign-debt crisis. BorgWarner's European sales began to slump six years ago and the drop accelerated over the past two. In 2011, 56 percent of its sales were in Europe; now it's 51 percent.

While BorgWarner's competitors also have been hurt by the European slump, a larger percentage of BorgWarner's sales are there. Cummins' auto-parts unit, for example, gets about 17 percent of its revenue from Europe and the Middle East.

Because of BorgWarner's success over the past three years, Stover, for one, is taking a wait-and-see attitude.

'Real question'

"I'm not saying they can't continue it, but the conditions are always more challenging when the expectations are higher," Stover said. "The real question is what are the longer term sources of growth for BorgWarner and how is the company going to protect its margins."

Stover says "the market is quietly betting against them."

David Leiker, an analyst with Robert W. Baird & Co., has a hold on the stock.

"The reality is the last 18 months have been a bit of a struggle," he said in an interview. "BorgWarner is a fantastic company with great technology. The struggle has been that the valuation has gotten ahead of the earnings growth," though he added, "I think that's coming to an end."

Manganello will remain as executive chairman until he steps down at BorgWarner's April 24 annual meeting.

"The last five to seven years have been really special for the company," Stover said. "It's sort of unfair in a way for Verrier. The hardest thing to do is upstage an act like the one we've seen."